3Organization 8.1 Introduction 8.2 Partial Equilibrium Analysis of a Tariff8.3 The Theory of Tariff Structure8.4 General Equilibrium Analysis of a Tariff in a Small Country8.5 General Equilibrium Analysis of a Tariff in a Large Country8.6 The Optimum TariffChapter SummaryExercises
48.1 Introduction International Trade Theories: Free Trade They explain that free trade maximizes world output(specialization) and benefits all nations (higher indifferencecurve ).In Practice: Trade Restrictions (or Protection )All nations impose some restrictions ( such as tariffs,non-tariffs ) or regulations on the free flow of internationaltrade to protect the domestic economy from the foreigncompetition.The most historically used trade restriction has been the tariff.
58.1 IntroductionTariffTariff is a tax or duty levied on the traded commodity as itcrosses a national boundary. It can be classified an import tariffa duty on the imported commodity) and an export tariff (a dutyon the exported commodity).The import tariff is more important than export tariff, here the most of the discussion is the import tariffExport tariffs are often used by developing countries on their traditional exports to get better prices and raise revenues due to the ease of collection
68.1 Introduction Tariff Types Ad valorem tariff(从价税)expressed as a fixed percentage of the value of the tradedcommoditySpecific tariff (从量税)expressed as a fixed sum per physical unit of the tradedCompound tariff(复合税)A combination of an ad valorem and a specific tariffBefore and After Multilateral Trade SystemSee the following tables (data and case studies)
358.2 Partial Equilibrium Analysis of a Tariff Partial Equilibrium Effects of a TariffEffect of a Tariff on Consumer and Producer SurplusCosts and Benefits of a TariffConclusion
36Partial Equilibrium Effects of a Tariff Tariff Partial Equilibrium Analysis is most appropriate a small country caseThe tariff will not affect world prices and the rest of theeconomy (price taker)Partial Equilibrium Effects of a TariffSee Figure 8.1The nation is a small countryDX is the demand curve and SX is the supply curveIn the absence of trade, the equilibrium point EUnder free trade, the domestic production and consumption of commodity XAfter a 100 percent ad valorem tariff on the imports of X, the domestic production and consumption of X
37FIGURE 8-1 Partial Equlibrium Effects of a Tariff.
38Partial Equilibrium Effects of a Tariff Tariff Effects of Figure 8.1After the tariff, the domestic production (production effect ) increases while the domestic consumption (consumption effect ) of commodity X decrease;After the tariff, government revenue (revenue effect) increases and the trade volume (trade effect) decreases;ConclusionAfter the tariff in a small country case, production effect and revenue effect are the positive while the consumption effect and trade effect are negative.The consumer’s income redistributes to the domestic producer and government.
39Effect of a Tariff on Consumer and Producer Surplus Consumer SurplusConsumer surplus is the difference between what consumerswould be willing to pay for each unit of the commodity and whatthey actually pay. Graphically, consumer surplus is measuredby the area under the demand curve above the going price.Higher prices mean the smaller consumer surplus.Producer SurplusProducer surplus refer to the payment that need not be made inlong run in order to induce domestic producers to supply moredisadvantageous commodity with the tariff. The increase inproducer surplus also referred to as the subsidy of the tariff.Higher prices mean higher producer surplus.
40FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.
41Costs and Benefits of a Tariff Consumer and producer surplus can be used to measure the costs and benefits of the tariffAfter the tariff, the consumer surplus decreases while the producer surplus increasesThe decreased consumer surplus includes four parts:Production effectProtection effectRevenue effectConsumption effectCosts and Benefits of a TariffCosts: protection effect and consumption effect (deadweight loss)Benefits: Production effect and Revenue effect
42FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.
43Costs and Benefits of a Tariff ConclusionIncome redistributionTariff redistributes income from domestic consumers (who payhigher prices for the commodity) to domestic producers of thecommodity (which receive the higher price ) and from thenation’s abundant factor (producing exportable goods) to thenation’s scarce factor (producing importable goods)Economic inefficiencyTariff distorts the domestic resources to transfer from the mostefficient production of exportable commodities to the lessefficient production of importable commodities (deadweightloss)Case studies 8-3 and 8-4 (page )
44ConclusionPartial equilibrium analysis of a tariff utilizes the nation’sdemand and supply curves of the importable commodity andassume that the domestic price of the importable commodityrises by the full amount of the tariff. It measures the reductionin domestic consumption, increase in domestic production,reduction in imports, the revenue collected, and redistributionof income from domestic consumers (who pay higher price forthe commodity) to domestic producers (who receive a higherprice) as a result of the tariff. A tariff leads to inefficienciesreferred to as protection cost or deadweight loss.
45FIGURE 8-8 (Partial Equilibrium Effects of a Tariff in a Large Nation) Partial Equilibrium effects of a Tariff in a Large Nation (appendix A8.1 page 260)FIGURE 8-8 (Partial Equilibrium Effects of a Tariff in a Large Nation)
46Explanation of Figure 8.8SH refers to the home supply, SH+F refers to the total supply of X for the large nation;With free trade, the intersection point B is the equilibrium point of DH and SH+F, PX=$2 and QX=50 (of domestic supply is 20X=AC, foreign supply is 30X=CB);With a 50 percent ad valorem import tariff (T), the total supply will shift up by 50 percent and becomes SH+F+T. The new equilibrium point H , PX=$2.5 and QX=40 (of domestic supply is 25X=GJ, foreign supply is 15X=JH;
47Explanation of Figure 8.8Consumer surplus decreases: a+b+c+d, at the same time the nation’s government also collects e (terms of trade benefit) from foreign exporter ( because the nation is large nation, the smaller quantity of exports will be supplied at a lower price).The Welfare of the Large Nation with tariff – uncertainNet benefit: If e>b+d;Net loss: If e<b+d;No change: if e=b+d
48Conclusion of Figure 8.8One big difference from a small nation: the large nation can benefit from the terms of trade (because large nation can affect foreign export or world prices) while the small nation always incurs a net loss from a tariff equal to the protection cost or deadweight loss because the small nation does not affect foreign export or world price (e=0)Although the large nation can benefit from the terms of trade, foreigners are likely to retaliate with a tariff of their own. In the end both nations are likely to lose from the reduced level of trade and international specialization
498.3 The Theory of Tariff Structure The Rate of Effective ProtectionGeneralization and Evaluation of the Theory of Effective ProtectionConclusion
50The Rate of Effective Protection Nominal Tariff & Effective TariffNominal TariffIt means the tariff on imports of a final commodity.Effective TariffIt means the tariff not only on imports of a final commodityalso on imports of raw materials or intermediate goods for theproduction of a final commodity. Then calculating the realprotection effect.The rate of effective tariff: calculated on the domestic valueadded , or processing, that takes place in the nation exceedsthe nominal tariff rate (calculated on the value of the finalcommodity)
51The Rate of Effective Protection The Formula of Effective TariffG=(t-aiti)/1-aiG= the rate of effective protection to producers of the final commodity;t=the nominal tariff rate on consumers of the final commodity;ai= the ratio of the cost of the imported input to the price of the final commodity in the absence of trade;ti= the nominal tariff rate on the imported inputExample page 245ConclusionWhenever the imported input is admitted duty free or a lowertariff rate is imposed on the imported input than on the finalcommodity produced with the imported input, the effectiverate of protection will exceed the nominal tariff rate.
52Generalization and Evaluation of the Theory of Effective Protection If ai=0,g=t (the effective protection equals the nominal protection);Fore given values of ai and ti, g is larger the greater is the value of t;Fore given values of t and ti, g is larger the greater is the value of ai;The value of g exceeds, is equal to, or is smaller than t, as ti is smaller than, equal to, or larger than t;When aiti exceeds t, the rate of effective protection is negative
53FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff Structure in Industrial Countries.
54The nominal tariff is deceptive Tariff Escalation ConclusionThe nominal tariff is deceptiveTariff EscalationCascading tariff structure in most industrial nations:With very low or zero nominal tariffs on raw materials andhigher and higher rates the greater is the degree of processing.Tariff escalation makes the rate of effective protection on afinal commodity with imported inputs much greater than thenominal tariff rate would indicate.Tariff TheoryThe theory assumes that the international prices of thecommodity and of imported inputs are not affected by tariffsand that inputs are used in fixed proportions in production.
558.4 General Equilibrium Analysis of a Tariff in a Small Country General Equilibrium Effects of a Tariff in a Small CountryIllustration of the Effects of a Tariff in a Small CountryThe Stolper-Samuelson TheoremConclusion
56General Equilibrium Effects of a Tariff in a Small Country General equilibrium analysis is used to study the effects of atariff on production, consumption, trade, and welfare when thenation is too small to affect world prices by its trading. Thereare some assumptions as follows:When a small nation imposes a tariff, it will not affect prices on the world market, the domestic price of the importable commodity will rise by the full amount of the tariff for individual producers and consumers in the small nationAs for the whole of the small nation, its price remains constantThe government of the small tariff-imposing nation uses the tariff revenue to subsidize public consumption and /or for general income tax relief
57Illustration of the Effects of a Tariff in a Small Country Figure 8.5 (page 250)Nation 2’s PPF shows that it is a country with capital-abundance specializing in the production of commodity Y;Under free trade, if PX/PY=1 on the world market, it produces at Point B exchange 60Y for 60X with the rest of the world, its consumption at Point E on its indifference curve Ⅲ;With a 100 percent ad valorem tariff on imports of commodity X, the relative price of X rises to PX/PY=2 for domestic producers and consumers but at PX/PY=1 on the world market and for the nation as a whole. The domestic production is at Point F ( more production of importable X and less exportable Y). Its consumption at Point H’ ( but only 15 X for consumption, the remaining 15X is collect by the government in the 100 percent of import tariff on X)
58FIGURE 8-5 General Equilibrium Effects of a Tariff in a Small Country.
59Illustration of the Effects of a Tariff in a Small Country To summarize Figure 8.5Production effect : More of importable goods and less of exportable goodsConsumption effect : lower consumption than free tradeTrade effect : the decrease of the trade volumeWelfare effect: higher tariff will lead to return to its autarky point A in production and consumption. The tariff is called a prohibitive tariff
60The Stolper-Samuelson Theorem ContentThe theory postulates that an increase in the relative price of acommodity raises the return or earnings of the factor usedintensively in the production of the commodity. Thus, the realreturn to the nation’s scarce factor of production will rise withthe imposition of a tariff.ExplanationTariff on the imported labor-intensive commodity X, PX/PY risesfor domestic producers and consumers, and so the real wage oflabor.
61The Stolper-Samuelson Theorem ReasonImport Tariff on scarce factor of production more ofimportable production and less of exportable productionthe change of L/K ratio the earnings of the scarce factorof production risesThis theory explains that the small nation as a whole is harmed by the tariff, its scarce factor benefits at the expense of its abundant factor
62Conclusion When a small nation imposes an import tariff, the domestic price of the importable commodity rises by the full amount ofthe tariff for individuals in the nation. As a result, domesticproduction of the importable commodity expands whiledomestic consumption and imports fall. However, the nation asa whole faces the unchanged world price since the nation itselfcollects the tariff. These general equilibrium effects of a tariffcan be analyzed with the trade models developed in Part oneand by assuming that the nation redistributes the tariff revenuefully to its citizens in the form of subsidized publicconsumption and /or general income tax relief.
63ConclusionAccording to the Stolper-Samuelson theorem, an increase in the relative price of a commodity raises the return or earnings of the factor used intensively in its production. For example, if a capital-abundant nation impose an import tariff on the labor-intensive commodity, wages in thenation will rise. On the contrary, if a labor-intensive nation impose an import tariff on the capital-intensive commodity, rents in the nation will rise.
648.5 General Equilibrium Analysis of a Tariff in a Large Country General Equilibrium Effects of a Tariff in a Large CountryIllustration of the Effects of a Tariff in a Large CountryConclusion
65General Equilibrium Effects of a Tariff in a Large Country General equilibrium analysis is used to study the production,consumption, trade and welfare effects of a tariff for a largecountry case.Large CountryIt means it is large enough to affect the world price.Offer curvesWhen a nation imposes a tariff, its offer curve shifts or rotatestoward the axis measuring its importable commodity by theamount of the import tariff.To reduce the volume of trade but improve the nation’s terms of tradeNation’s welfare actually rises or falls depends on the net effect of trade volume and terms of trade
66Illustration of the Effects of a Tariff in a Large Country Figure 8.6With free trade, the equilibrium point of two nations’ offer curves is at E ;After the imposition by Nation 2 of a 100 percent ad valorem tariff on its imports of Commodity X is reflected in Nation 2’s offer curve rotating to offer curve 2’ , the tariff-distorted offer curve 2’ is at every point 100 percent or twice as distant from the Y-axis as offer curve 2 . The new equilibrium is at Point E’, Nation 2’s terms of trade improves (PX/PY=0.8) while Nation1’s deteriorates (PX/PY=1.25).The steeper or less elastic Nation 1’s offer curve is , the more its terms of trade deteriorate and Nation 2’s improve
67FIGURE 8-6 General Equilibrium Effects of a Tariff in a Large Country.
68Illustration of the Effects of a Tariff in a Large Country For Nation 2 as a whole, the import 50X by Nation 2 at equilibrium point E’, 25X is collected in kind by the government of Nation 2 as the 100 percent import tariff on commodity X and only the remaining 25X goes directly to individual consumers.Explanation of Figure 8.6When large Nation 2 impose a tariff, the volume of trade declines but its terms of trade improve.For individual consumers and producers in Nation 2, PX/PY=PD=1.6, or twice as much as the price on the world market and for the nation as a wholeStolper-Samuelson theorem also holds in a large nation. If PX/PY falls, it is known as the Metzler paradox ( discussed in the appendix)
69ConclusionWhen a large nation imposes an import tariff, its offer curve rotates toward the axis measuring its importable commodity by the amount of the tariff, reducing the volume of trade but improving the nation’s terms of trade.The Stolper-Samuelson theorem refers to the long run when all factors are mobile between the nation’s industries.Stopler-Samuelson theorem explains the reason of tariff imposition in nations: Import tariff can increase the real returns of the nation’s scarce factor of production.
708.6 The Optimum TariffThe Meaning of the Concept of Optimum Tariff and RetaliationIllustration of the Optimum Tariff and RetaliationConclusion
71The Meaning of the Concept of Optimum Tariff and Retaliation Optimum tariff is the rate of tariff that maximizes the netbenefit resulting from the improvement in the nation’s terms oftrade against the negative effect resulting from reduction inthe volume of trade.Tariff RetaliationAs the terms of trade of the nation imposing tariff improve,those of the trade partner deteriorate. As a result, the tradepartner is likely to retaliate and impose an optimum tariff on itsown. If the process continues, all nations usually end uplosing all or most of the gains from trade. The world as awhole is worse off than under free trade.
72Illustration of the Optimum Tariff and Retaliation FIGURE 8-7 The Optimum Tariff and Retaliation.
73ConclusionThe nation’s benefit comes at the expense of other nations, the latter are likely to retaliate, so that in the end all nations usually lose;An optimum tariff for a small country is zero (since a tariff will not affect its terms of trade and will only cause the volume of trade to decline (Figure 8.6 points E and H’). No tariff can increase the small nation’s welfare over its free trade position even if the trade partner does not retaliate;An optimum tariff for a large country is easy to arouse tariff retaliation.
74Chapter SummaryTariff imposition has four effects: production effect, protection effect, revenue effect consumption;Tariff reduces the nation’s welfare and leads to the decline of trade volume;Tariff can increase the returns of the domestic scarce factor of production (Stolper-Samuelson);Tariff is easy to arouse the retaliation .
75ExercisesDiscussion Problems:Page 258 to 259 from 1 to 14 questions
76Exercises Additional Reading Comprehensive surveys of trade policies, in general, and thetheory and measurement of tariffs, in particular, are:W.M.Corden, The Theory of Protection (London: Oxford University Press, 1971)J.N.Bhagwati, in R.C.Feenstra, ed., The Theory of Commercial Policy (Cambridge, Mass.: MIT Press, 1983)J.N.Bhagwat, Protectionism (Cambridge, Mass.: MIT Press, 1988)For measures of the cost of protection, see:G.H.Hufbauer, D. T. Berliner, and K. A.Elliott, Trade Protection in the United States: 31 Cases (Washington, D.C.: Institute for International Economics, 1986)